In my post about payment management, I mentioned that one of the methods used to manage payments is a payment application process.
This is a process that occurs before the contractor presents an invoice. The process includes a review of the work to validate the contractor’s claims.
There are several key steps to this process so, I felt it was best if we reviewed this in detail.
Schedule of Values
We have previously discussed the need for a schedule of values. A schedule of values is a list of contracts or tasks necessary for performing the work.
I like to request that this list is arranged according to Work Breakdown Structure (WBS) of the Construction Specifications Institute (CSI), but it may be simpler for the contractor to break-down his list according to his list of sub-contracts. You can use any recognized WBS (some countries have their own). How the Schedule of Value is arranged is not as important as making sure you have one.
The intent is to have a list of tasks with associated dollar values that represent the work to be completed. Each task has a dollar value, all dollar values add up to the total value of the contract.
As work is completed, the contractor must document the percent complete for each task. The dollar value for each task is then multiplied by the percent complete. This returns a number that is the amount due for the current work period for each task. The amount due for all tasks is then added up to determine the total due to the contractor for that period of work.
The contractor must also track previous amounts paid and the process repeats itself until the work has been completed and all sums have been paid.
The payment application process is a two-step process.
First, the contractor must document for himself the amount of work that was completed for each task on the Schedule of Values. This typically involves conversations with each trade foreman. Remember that many times these payments are nothing more than payments the contractor has to make to a subcontractor. The contractor’s first duty here is to regulate the demands of the subcontractors to ensure that they are invoicing appropriately according to the work they have completed.
This is a critical first step.
The contractor may then also add in costs associated with materials or equipment that they purchased. They also add in their general conditions costs, profit, and any approved change orders.
The second part of the process is the Architect’s review.
The payment application process works only when you have an independent third party familiar with the project that can verify and validate the contractor’s claims for payment.
Typically if you are using a design bid build delivery model, you will have two separate entities (one for design and one for construction) which report directly to the Owner. These two parties help the Owner manage each other.
The Architect will review the Contractor’s Application for Payment looking at the percent of completion claimed by the Contractor for each line item. If the Architect agrees with the percentages claimed by the Contractor, he will certify the payment application in full. If the Architect disagrees with any of the percent complete claims, he may “short” the payment accordingly to reflect what he believes is the right percent complete for the work.
The certified application then goes to the Owner.
What can be claimed
As noted above, the amount claimed in each application should coincide with the percentage of work completed for each contract, but there are some exceptions.
Equipment purchases and material purchases typically require immediate payment, but sometimes (especially with equipment) the product may not be on site until several weeks later.
For items such as this, the contractor may be required to present proof of purchase or other documentation to show that they were required to make a payment. Regardless, the contractor’s application for payment may include payments for up-front monies. These can be allowed as long as proper evidence of payment is provided.
Sometimes contractors will purchase materials, but those materials might not be onsite or installed. This can happen when some kind of fabrication work is required (such as with storefronts).
The contractor may ask to be paid for materials that were purchased and received but not onsite. This can be allowed as long as you have evidence that the materials were paid for and received and that the materials are specifically set aside for the project. This may require a trip to the contractor’s yard or photos of the material.
You do not want to pay for any materials that were purchased in bulk and co-mingled with other orders. This is a common practice of certain specialty sub-contractors. They buy materials in bulk orders to accommodate current and future jobs. They do this because they are buying traded raw materials (like aluminum and steel) and they are trying to “time the market” (to buy low). Their bulk order may include materials for your order and many others. Such purchases cannot specifically track the materials for your order and should not paid for until the materials are onsite and installed.
During the payment application process, the Architect has a duty to walk the jobsite and be familiar with the work that has been completed. The Architect should understand the scope of the design and be able to recognize the approximate percentage of completion relative to the planned work.
Architects will not negotiate contract values and they will not audit invoices. In most cases, Architect’s will not even opine on the value of change orders.
Another thing the Architect does not do is certify that the work that has been completed was installed correctly. This may be a shocking statement for some, but remember that means and methods of construction are not in the Architect’s purview. The responsibility for ensuring that the proper means and methods remains strictly with the Contractor.
This is an important limitation Owner’s must understand.
The only role the Architect has is in reviewing the level of work completed and certifying that they believe the work has been completed according to the percentages shown on the application for payment.
Making the payment
Once the application for payment process has been completed and the Owner has received the Architect’s certification, a payment can be made.
This typically requires the Contractor to produce a formal invoice that reflects the amount certified by the Architect.
If your contract included provisions for retained amounts, the invoice must show the certified value minus the amount to be retained.
The invoice must also include lien waivers from each trade.
The complete invoice must include the certified payment application, the invoice, and lien waivers from each trade.
Once all of these are in hand, then the Owner can issue a payment.
The application for payment process does require a little time and some effort, but in the end, it is the most effective way to protect Owners from over-payment.
I’m also sensitive to the fact that the extra time means that Contractors are burdened with a longer period of waiting to be paid. This impacts the Contractor’s sub-contracts as well. When you compound all of these processes together it means trades may wait longer than 60 days from the date they completed work until they receive payment. This is an unfortunate circumstance, but the Owner’s risks are very high. Mitigating the Owner’s risk must weigh in higher than the trade having to wait for payment.
What do you think? Are there any other steps you take to mitigate the Owner’s risk? Are there other processes that you use? Tell me your stories.
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